Find Cash in Trash

Damian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When I was little, my mom and grandma used to tell me that one man's trash is another man's treasure. Clean Harbors (NYSE: CLH), Waste Connections (NYSE: WCN) and Republic Services (NYSE: RSG) are proof that they weren't wrong. These companies have built highly profitable, multi-billion-dollar businesses out of waste management. Let’s take a look at them and try to elucidate if they are good long-term investments or not.

All kinds of trash

Clean Harbors provides a wide array of environmental services in the U.S., operating in five segments: technical services Oil Re-refining and Recycling, SK Environmental Services, Industrial and Field Services, and Oil & Gas Field Services. It leads in various segments of the waste management industry, controlling roughly 70% of North America’s commercial incineration capacity and approximately 20% of hazardous materials landfill capacity. Moreover, the firm’s hazardous waste management assets provide it with a strong advantage that looks very difficult to match (Morningstar).

In this industry, expertise really matters; it might be the difference between complying with environmental regulations and not being able to operate. Fortunately, Clean Harbors already knows the drill. Furthermore, a trend toward stricter environmental regulation makes compliance more expensive and difficult, and incentives for outsourcing greater. Clean Harbors seems poised to benefit from this situation over the years to come. Even further, the company holds a strong position to benefit from the increasing volume of hazardous waste as the economy recoups, and from new shale plays like Bakken.

Due to high switching costs, the company enjoys a substantial client stickiness and a steady source of revenue. This has resulted in continuous revenue growth over the past few years. This growth was boosted last quarter by the acquisition of Safety-Kleen, which helped revenue rise by over 50% YoY, contributing more than 200,000 clients and an important business diversification. Actually, it has provided leading exposure to the oil re-refining segment. Going forward, multiple cross-selling opportunities open new roads for growth.

As a result, analysts expect the firm to deliver an EPS growth rate around 46% this year and an average of 13%-14% per year over the next five. So, trading at 28 times its earnings, slightly above the industry average, I would recommend buying and holding this stock. Upside potential is significant, especially after the Safety-Kleen purchase.

Small towns, big business

Waste Connection operates in the solid waste segment, providing collection, transfer, disposal, and recycling services in secondary markets of the Western U.S. Over the past several years, the firm has been posting double-digit top-line revenue growth, even through rough economic patches. By serving less-competitive markets, the company has acquired a considerable pricing power, mainly due to the lack of competition. In addition to this stable market, the company has made an incursion in the E&P waste segment, one of higher potential and margins, mainly through the acquisition of R360 Environmental Solutions, a leading provider of non-hazardous oilfield waste treatment and disposal services in the U.S.

Considerably moated against competitors and holding strong pricing power, Waste Connection has outperformed its peers, delivering an operating margin of 19.5% (TTM), versus the 13.2% industry average. These features have also impacted the firm's beta of 0.5.

Although prospects do not look bad, analysts expect the firm to deliver an average annual EPS growth rate around 12%, underperforming its peers. Meanwhile, Waste Connection's stock trades above industry average valuations in relation to its earnings, sales, and book-values. Concerned by increased competition in the E&P segment, the firm's dependence on acquisitions to maintain growth levels, and its assets building faster than its revenue, while trading close to a ten-year high, I'd recommend holding until the valuation becomes more attractive.

Not a trashy investment

Republic Services is one of Waste Connection's main competitors. As the second largest non-hazardous waste management company in the U.S., only behind Waste Management (NYSE: WM), it has dug an economic moat for itself, mainly on the back of its vertical integration and the resulting “operational efficiencies and scale advantages that are difficult for local operators to replicate” (Morningstar). Unlike Waste Connection, however, the company experienced a decline in revenue during the last recession. So, why invest in Republic Services?

Even through the economic turmoil and decreasing revenue, the firm managed to generate increasing profits and margins, proving its resilience. As the economy recovers, further profit growth should derive from higher volumes and yields. Meanwhile, an expanded landfill base will also provide some upside.

Cash is important for Republic Services. As demand increases and regulations become stricter, investments in recycling and eco-friendly processing methods will separate successful companies from declining ones. Free cash flow will be also used to pay out dividends, repurchase shares, and pursue strategic acquisitions.

Moreover, as stated by Zacks analysts, “Republic Services is currently focusing to increase its operational efficiency by converting to compressed natural gas collection vehicles and conversion of rear-loading trucks to automated-side loaders, which will reduce cost and improve profitability.”

So, trading at 22.6 times its earnings, at about a 15% discount to the industry average, while offering compelling and attainable growth prospects and targets, I'd recommend buying and holding this stock.

Bottom line

Although all three companies offer compelling growth prospects and look reasonably valued, I believe that the smallest of them in terms of market cap, Clean Harbors, stands as the best investment opportunity for the long-term. With a moated and increasingly specialized business, steady sources of income, plenty of cash and, especially, a great outlook for the years to come, this is a stock you should include in your investment portfolio.

The Motley Fool's chief investment officer has selected his No. 1 stock for this year. Find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.

Damian Illia has no position in any stocks mentioned. The Motley Fool recommends Republic Services and Waste Management. The Motley Fool owns shares of Clean Harbors and Waste Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus